China: Political due diligence in the age of new energy vehicles

20 Oct 2017

China

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Automotive

China: Political due diligence in the age of new energy vehicles

China in September introduced the world’s most ambitious new energy vehicle (NEV) quotas. The new rules will require all automakers manufacturing or importing more than 30,000 vehicles to obtain an NEV credit of 10% of all sales by 2019, with the number set to rise every year.

The move is proof of China’s commitment to winning the NEV race – leapfrogging conventional automotive technology, where it has lagged behind foreign competitors – to dominate the new energy vehicle market both in China and the world. The quotas are a first step in a paradigm shift for the automotive industry that will see significant changes to its business model in the coming years. Whether auto manufacturers and suppliers will emerge as winners or losers of this change will depend on how skilfully companies in the sector respond to the new regulatory environment, and who they chose as their partners.

New cars, same market access challenges

Beijing’s NEV policy aims not just to improve energy security and reduce pollution, but is primarily geared towards building a competitive domestic NEV industry to compete with foreign auto giants both in China and abroad. The policy benefits domestic auto companies, which produce the majority of NEVs sold in China. Under the new quota system, manufacturers that cannot meet the production quota can buy credits from companies with higher NEV capacity. This move is expected to financially benefit China’s strongest NEV players. Many foreign automakers are also relying on their joint venture (JV) partnerships to produce lower-end NEVs in an attempt to meet the quota for the first one to two years.

Reports of market access liberalisation for foreign automakers are therefore unlikely to improve the competitiveness of foreign firms. Media reports suggested that any NEVs produced without a JV in a free trade zone (FTZ) to be sold in China would still be subject to an import tax, and would not qualify for any government subsidies. A similar pattern could be seen with NEV battery rules – China in 2016 allowed for battery production in FTZs without a JV requirement, but simultaneously introduced new technical standards that significantly disadvantaged the main foreign competitors relative to Chinese battery makers. Foreign auto and battery manufacturers will likely continue to require local partners to access the auto market at no additional cost, even if regulations change.

New partners, more problems

Most major foreign players have in the past year announced NEV research co-operation ventures or JVs with Chinese companies, and many more partnerships are being formed to pursue autonomous driving and to stay ahead of changing car ownership and transport models. In selecting partners to brave the new autonomous, electric world, foreign companies in China should consider the following:

Viability – While the government wants to boost NEV supply, it also wants to cull or merge inefficient, technologically backward operations, and is therefore likely to restrict approvals for NEV production over the next six months to a year. The government is also determined to prevent the emergence of overcapacity in the NEV space after a surge of government subsidy programmes led to a proliferation of NEV companies. Companies therefore need to have an in-depth understanding of their potential partner’s market position, how important they are to the local economy as well as the degree of government support and extent of local connections.

Integrity – China’s anti-corruption and anti-bribery enforcement will not weaken in President Xi Jinping’s second term. Senior personnel changes in the past few months suggest further high-profile corruption investigations into the state-owned auto sector are likely after the 19th Communist Party Congress currently being held in Beijing. Understanding a potential partner’s modus operandi, including how they secure projects, maintain client or government relationships, and their ties to specific government officials will be crucial to understanding a partner’s vulnerability to the ongoing corruption crackdown. As the level of detail required is often not found in public media sources, on-the-ground enquiries into potential partners may be necessary.

Politics – Companies must keep government priorities in mind not just when selecting but also when determining the type of partnership they want to engage in. With industrial policies such as ‘Made in China 2025’ stressing the development of national champions, it is worth considering whether an NEV partner will support or undermine a long-term global NEV strategy. Whether the partner presents a significant threat of intellectual property theft or a means to access significant investments will depend on a thorough strategic risk review as well as proactive local and national stakeholder engagement.

China’s NEV shift, while the most stringent policy to date globally, is not happening in isolation. Numerous jurisdictions – from California to Germany – are discussing quotas and other restrictions or incentives to promote the production of NEVs. China’s policymakers will strive to remain ahead in terms of a pro-NEV regulatory environment. Foreign automakers are likely to meet their NEV partnership challenges here first.

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